The Inflation Versus Deflation Argument - Part 4

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

While it is true that the U.S. experienced consumer price deflation in the 1930s and Japan did so in the 1990s and both experienced sharp drops in bank credit, there are few if any other similarities to the current situation in the United States in 2008. The situation in the 1930s U.S. and 1990s Japan is also a bit more nuanced that the deflationists would have you believe. In the late 1920s, the U.S. did see a big rise in money supply and credit, just as occurred in the U.S. in the early 2000s. According to the deflationists, this should have resulted in rising U.S. consumer prices at some point. It did not. Prices actually fell between 1926 and 1929. A similar thing happened in Japan in 1986. While consumer price deflation did appear in Japan after its banking system literally fell apart, it didn't show up consistently until 1999, nine years after the Japanese asset bubble began to burst. Based on these observations, the relationship between consumer prices and money supply and credit seem to be rather tenuous at best.

The deflations in the 1930s U.S. and 1990s Japan did have an important element in common that does not exist today - dropping commodity prices. As early as the spring of 1929, farm commodities in the U.S. experienced a sharp drop. All commodities declined in the crash month of October and then they crashed themselves in the spring of 1930 . While commodity prices didn't crash in the 1990s, they were weak throughout the decade. Oil reached its price low of just over $10 a barrel in 1998. Ten years later it would be almost 15 times higher. Not only were commodities not declining in the 2000s, but they were experiencing major price increases resulting in significant inflation in the U.S. and most of the world. The commodity picture in the 2000s was just the opposite of the early 1930s U.S. and 1990s Japan.

The import/export and deficit picture has no similarity to the contemporary U.S. either. In the late 1920s, the U.S. had a massive trade surplus and was the biggest creditor nation in the world. Its boom had been built on exports as was the case for Japan in the later twentieth century. Drops in exports damaged both economies. On the other hand, the U.S. in the 2000s was the biggest debtor nation in the world having both a massive trade deficit and government debt, which required heavy borrowing and had inflationary implications. Japan in the 1980s was similar to the U.S. in the 1920s and both were very dissimilar to the U.S. in the 2000s.

Currency also plays a different role in all three scenarios. The U.S. was on the gold standard until 1933 and even after that the currency didn't float. The Japanese yen traded relatively flat during the 1990s. In neither case, did currency have a significant deflationary or inflationary effect, in contrast to the U.S. in 2008 where currency played an inflationary role. The U.S. dollar dropped to all time lows in late 2007 because of the Federal Reserves easy money policy. Since the U.S. imported much more than it exported, this raised import prices and had a bigger inflationary impact than it would have had otherwise.

NEXT: The Inflation Versus the Deflation Argument - Part 5

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

For more about us, please see our web site: http://investing.meetup.com/21

The Inflation Versus Deflation Argument - Part 3

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

For a theory to be valid, it must produce results consistent with reality. Neither the deflationist arguments in Wiemar Germany in the 1920s, nor those made in 2008 in the United States could meet this most basic of all criteria. The contemporary U.S. deflationists are claiming that an era of lower prices is upon us even though consumer prices are continuing to rise and the rise seems to be accelerating. Both groups of deflationists redefined inflation to be something else, or in other words, they changed reality to match their theory instead of the other way around. In neither case was any relationship demonstrated by them between their definition of inflation and changes in consumer prices.

The deflationists claim that inflation is an increase in money supply plus bank credit. While everyone could agree that bank credit in the United States was falling in 2008, the same could not be said for money supply. Their are many definitions of money supply and M3, a broad category that would include the Federal Reserves newly created money pumping operations such as the TAF, TSLF and PDCF was expanding rapidly. Since the deflationist argument would fall apart using their own criteria if M3 figures were used, they chose to look at much narrower definitions of money supply such as M2 to try to support their theory. Even then, M2 was experiencing robust growth of over 6% until the second quarter of 2008, when it slowed to around 1%. This was hardly the dire collapse that the deflationists claimed to be happening.

Logically, the deflationist definition is inherently defective because it considers inflation to be a local rather than a global phenomenon. In an era with worldwide commodity trading, prices are set globally for key components of consumer inflation such as energy and food products, not based on what's happening in a single country. Under such circumstances, currency fluctuations then determine the different rates of inflation between countries.

The deflationists argument is also too limited in that it considers money supply and credit, but not assets. In a rich developed country, people can spend their wealth (liquid and tangible assets) as well and they will if they need to do so to buy necessities. This is exactly what happened in Wiemar Germany, where the middle and even upper classes sold their family's prized possessions in order to eat.

The U.S. deflationists also try to bolster their case with comparisons to what is happening in the United States now and what happened in the deflationary periods of the 1930s U.S and the 1990s Japan. Only the most superficial comparison shows any similarities between the U.S. in 2008 and these earlier time periods. Under closer examination the deflationist comparisons completely fall apart.

NEXT: The Inflation Versus Deflation Argument - Part 4

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

For more about us, please see our web site: http://investing.meetup.com/21

The Inflation Versus Deflation Argument - Part 1

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

One of the Federal Reserves two major purposes is to provide price stability for the American economy, a goal they chose to abandon in September 2007. While the Fed's interest rate policies after that time were highly inflationary, Fed officials excused their actions by denying that inflation was a problem, making rosy predictions that it would subside, and by assuring the public that they were capable of handling it and taking care of it in case it became a problem. None of this was true of course and the Fed's position increasingly lost credibility as gasoline and food prices skyrocketed in the U.S.

The Fed's biggest cover for its actions was the official inflation figures produced by the U.S. government statistical agency, the BLS (Bureau of Labor Statistics). The method of calculating the CPI (Consumer Price Index) was modified several times during the 1980s and the 1990s, with each modification producing a lower reported inflation number. Essentially these modifications involved reducing the importance in the CPI calculations of anything that was experiencing significant prices rises, thereby automatically lowering the final reported inflation numbers. It was hard for significant inflation to show up in the official government figures given this approach. By May of 2008, year over year CPI was only 4.2% in the U.S. despite rapidly rising energy and food prices during that period.

Recalculating CPI using the 1970s methodology indicated U.S. inflation was more likely around 12% (for more info: http://www.shadowstats.com/), almost as bad as it had been at its height in 1980. It became increasingly hard to convince the public otherwise, when the average U.S.consumer saw regular price increases at the gas pump and in the supermarket. Nevertheless, U.S. media continued to dutifully report the unrealistic official inflation figures as if they were true, helping the Federal Reserve perpetuate the fantasy on which it based its irresponsible monetary policy.

While the Federal government altered inflation calculations to produce the desired numbers in order to fool the general public about current inflation, lying about future inflation could not be done so easily. The augurs of where inflation was going, the money supply, are generally only looked at by the financially sophisticated. To solve this problem, the Federal Reserve simply stopped publishing the broad M3 money supply figures, the most telling number series of all, in 2006. Since many people realize that when a government hides information, its almost always information that would be particularly damaging if known, attempts to reconstruct M3 by private parties began immediately. By the spring of 2008, the reconstructed figures indicated that M3 was growing at approximately 20% (MZM, zero money, or cash and its equivalents was growing at an over 30% rate). The money supply figures indicated that U.S. consumer inflation was likely to peak at a minimum of 20% to 30% sometime around 2011. Depending on future readings, much higher inflation levels were possible.

The U.S. government's long-term misinformation campaign about inflation rates and its secrecy concerning money supply figures apparently didn't provide enough cover for the Federal Reserve. One group of apologists for the Fed (and the Fed had a legion of apologists who were feeding off the easy money gravy train that it was providing them at the expense of the American public) began publishing arguments about the risks of deflation in the U.S and how this justified an even easier money policy. Claiming that deflation actually existed in a period when inflation was getting out of control was by no means a new idea. It was in fact a prelude to some of the worse inflationary episodes in history.

NEXT: The Inflation Versus Deflation Argument - Part 2

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

Daryl Montgomery,
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21